Factor Investing is a systematic and quantitative data-driven approach to investing that seeks to instil rigor and discipline, and to consistently capture excess returns from specific risk factors. Style factors seek to capture excess returns previously attributed to investor behaviours. Among these factors, Value and Quality are the most intuitive and are most actively used in systematic fixed-income portfolios.
According to Invesco’s 2021 Global Factor Investing Study, more than 90% of investors believe Factor Investing can be successfully applied to fixed income. The most common uses cited for factor-based investment strategies were: reduce risk, increase returns and control portfolio exposure. Moreover, investors believe that fixed-income factor approaches are useful in targeting specific investment factors, and are a good complement for active managers.
That said, investors also highlighted two challenges to fixed-income Factor Investing: (1) a lack of products; and (2) technology. This is evident in ETFs, where the usage of fixed-income factors is limited compared to equities. SQN addresses these challenges.
Our investment approach is best described as “fundamental quant”, or the use of quantitative methods to identify and systematise insights grounded in financial economics research. Our investment philosophy is simple and time-tested: buy good-quality credit at attractive prices.
According to Invesco’s 2021 Global Factor Investing Survey, nearly 80% of respondents include ESG data and analysis in investment decision-making, while another 15% are considering it. About 75% of investors believe that integrating ESG enhances long-run investment performance, mainly through the mitigation of investment risk.
While there is no consensus on whether ESG itself should be defined as an investment factor, nearly 75% of investors apply ESG filters to their investment universe before incorporating a factor-based model.
The SQN platform is flexible and strategy-agnostic. This means a portfolio manager can use SQN to implement the full range of strategies, from pure quantitative (including using SQN’s proprietary style factors, Value and Quality) to fundamental active.
That said, Lucror’s preferred investment approach is a core quantitative process with fundamental oversight. Specifically, we leverage the experience of our credit-analysis team to identify and mitigate risks that cannot be captured in the data, hence combining technology and solid human expertise for optimal results. This fundamental oversight is available on the SQN platform, and can be leveraged by SQN users to fine-tune their portfolios.
The C-Score is a measure of market-implied issuer credit quality that is updated daily. Hence, it is timelier, more granular, and more reflective of market sentiment towards the issuer than other measures of credit quality that are available currently. Therefore, its practical applications include:
SQN currently features three functionalities to incorporate ESG considerations into the investment process:
At its core, SQN seeks to address the technological challenges that an investment manager without substantial scale might face, especially in implementing Factor Investing and applying a rigorous, disciplined, systematic, quantitative data-driven investment process. SQN offers the tools to:
Lucror has dedicated quantitative, research and technology teams supporting SQN. In addition, we draw on our credit-analysis team’s expertise for qualitative risk mitigation i.e. to identify and highlight major downside risks through fundamental research.
For clients who prefer an investment approach that combines quant and fundamental research, we offer credit research overlay, whereby a team of senior analysts’ pre-screen and qualify issuers for quantitative selection.
The research team is also responsible for creating and maintaining special-interest lists (e.g. Approved Investable Lists, Credit Blacklist) that can be used during portfolio construction and rebalancing.
Portfolio construction and management in SQN is a three-step process:
SQN addresses these critical aspects of portfolio construction and management through the Portfolio Builder module. SQN does not prescribe a particular set of fixed exposures, given that various portfolios and mandates can have different benchmarks with varying duration, sector and regional exposure, in addition to client constraints and risk appetites. Instead, SQN shortlists issues based on Lucror’s Factor Investing approach, and proposes an initial portfolio that is naturally overweight sectors and regions that are more attractive. Subsequently, SQN facilitates the transformation of the initial shortlist into a portfolio that aligns with the portfolio manager’s requirements and risk appetite. Thus, SQN screens for trends (risks) and ensures a well-balanced portfolio from an industry and country-allocation perspective.
Traditional factor-based portfolio rebalancing identifies the best opportunities at a certain time, without taking into account the existing portfolio positions i.e. whether the newly identified opportunities are indeed more attractive than current portfolio positions after accounting for transaction costs.
SQN’s Rebalancing module is designed to systematically identify and capture new opportunities that consider the hurdle spread. Our proprietary rebalancing algorithm compares the new portfolio selection with a portfolio’s existing holdings, to prioritise the issue pair swaps that offer the greatest yield pick-up.
New issues that have yet to be priced by the market need to be assessed against their sector and the portfolios under consideration, in order to help portfolio managers decide whether these issues add value to their portfolios. While it is relatively straightforward to assess issues already trading on the secondary market against a portfolio using the Rebalancing module, it is less straightforward for primary issues which have not yet been priced, and portfolio managers frequently have to decide whether to subscribe to a new issue before pricing occurs.
To help portfolio managers make this decision and ensure that any new issues subscribed to add value to the portfolio, SQN’s New Issue module estimates the term structure of the OAS, YTM and YTW for a selected issuer, industry and selected peer group. This gives the portfolio manager a range of possible price points for the new issue. As the peer group can be customised based on quality (C-Score), grade, region and other filter criteria available in SQN, the portfolio manager has the flexibility to estimate the term structure, and hence the new-issue pricing, based on various scenarios, and to further refine estimates.
The second key decision that the portfolio manager needs to make is whether the new issue adds value to the portfolio, and consequently whether it is worth subscribing to. To help with this decision, SQN’s New Issue module also plots the term structure of the selected portfolio against the estimated new issue. This enables the portfolio manager to visually and instantly identify whether the new issue is likely to add value (i.e. yield or spread) to the portfolio.